"Are Economists to Blame for the Crisis?"

Via Michael Greinecker at Yet Another Sheep:

[Video on continuation page]

Are Economists to blame for the Crisis?: To a large degree: Yes. At least that´s what Stiglitz said at a presentation at my beloved university...:

 
[Stiglitz starts at 5:20]

Comments

[bullbust]

I have been called an idiot, termed clueless about economics and so on and for saying the exact same thing here - that economists live in ivory towers.

Here is Naomi Klein. She is not an economist. But economists should understand what she is trying to say. "Kill the lawyers", in the middle ages, was a well justified by the interests the lawyers advanced.

Read the whole thing at http://www.democracynow.org/2008/10/6/naomi_klein.

Now, one of the things that comes up again and again in the writings of University of Chicago economists of the Friedman tradition, people like Arnold Harberger, is this appeal to nature, to a state of nature, this idea that economics is not a political science or not a social science, but a hard science on par with physics and chemistry. So, as we look at the University of Chicago tradition, it isn’t just about a set of political and economic goals, like privatization, deregulation, free trade, cuts to government spending; it’s a transformation of the field of economics from being a hybrid science that was in dialogue with politics, with psychology, and turning it into a hard science that you could not argue with, which is why you would never talk to a journalist, right? Because that’s, you know, the messy, imperfect real world. It is beneath those who are appealing to the laws of nature.

Now, these ideas in the 1950s and ’60s at this school were largely in the realm of theory. They were academic ideas, and it was easy to fall in love with them, because they hadn’t actually been tested in the real world, where mixed economies were the rule.

Now, these ideas in the 1950s and ’60s at this school were largely in the realm of theory. They were academic ideas, and it was easy to fall in love with them, because they hadn’t actually been tested in the real world, where mixed economies were the rule.

Now, I admit to being a journalist. I admit to being an investigative journalist, a researcher, and I’m not here to argue theory. I’m here to discuss what happens in the messy real world when Milton Friedman’s ideas are put into practice, what happens to freedom, what happens to democracy, what happens to the size of government, what happens to the social structure, what happens to the relationship between politicians and big corporate players, because I think we do see patterns.

Now, the Friedmanites in this room will object to my methodology, I assure you, and I look forward to that. They will tell you, when I speak of Chile under Pinochet, Russia under Yeltsin and the Chicago Boys, China under Deng Xiaoping, or America under George W. Bush, or Iraq under Paul Bremer, that these were all distortions of Milton Friedman’s theories, that none of these actually count, when you talk about the repression and the surveillance and the expanding size of government and the intervention in the system, which is really much more like crony capitalism or corporatism than the elegant, perfectly balanced free market that came to life in those basement workshops. We’ll hear that Milton Friedman hated government interventions, that he stood up for human rights, that he was against all wars. And some of these claims, though not all of them, will be true.

But here’s the thing. Ideas have consequences. And when you leave the safety of academia and start actually issuing policy prescriptions, which was Milton Friedman’s other life—he wasn’t just an academic. He was a popular writer. He met with world leaders around the world—China, Chile, everywhere, the United States. His memoirs are a “who’s who.” So, when you leave that safety and you start issuing policy prescriptions, when you start advising heads of state, you no longer have the luxury of only being judged on how you think your ideas will affect the world. You begin having to contend with how they actually affect the world, even when that reality contradicts all of your utopian theories. So, to quote Friedman’s great intellectual nemesis, John Kenneth Galbraith, “Milton Friedman’s misfortune is that his policies have been tried.” ....

[Robinia]

Yes-- that is what makes understanding so lonely, that so many have got it wrong, and, in their wealth and status and hubris, keep assuring one another that they are so smart. Thanks so much for posting this here. That, and this news: Paulson is, in fact, educable.

http://www.nytimes.com/2008/10/09/business/economy/09econ.html?hp

Things are, finally, looking up a bit.

[Chris Rich]

I'd Say it all depends on which economists. Chicago school shills like that Minkewicz, (sic) fellow clearly are a menace.

But I am quite at peace with Keynsians.

A word from the 'Lord'

"Keynes affirmed the central role of liberal ethics in economics -- and urged the progressive archbishop to speak out forcefully on issues of economic and social justice. This was, after all, an economist who, on a different occasion, had said modern capitalism was "absolutely irreligious, and without internal union, without much public spirit, often, though not always, a mere congeries of possessors and pursuers," and who cursed "the hag-ridden" worship of "the money-motive."

"Keynes instead foresaw a time when "the love of money as a possession -- as distinguished from the love of money as a means to the enjoyments and realities of life -- will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease."

Keynes was just as unambiguous about the role we could expect of conservatives in helping reach such a world: "Conservatism leads nowhere; it satisfies no ideal; it conforms to no intellectual standard; it is not even safe, or calculated to preserve from spoilers that degree of civilisation which we have already attained."

"Moreover, he left no doubt about how their resistance to liberal reforms ought to be addressed. "There is no reason," he wrote, "why we should not feel ourselves free to be bold, to be open, to experiment, to take action, to try the possibility of things. And over against us, standing in the path, there is nothing but a few old gentlemen tightly buttoned up in their frock coats, who only need to be treated with a little friendly disrespect and bowled over like ninepins."

[jonfernquest]

Thanks. This was brilliant and harsh but the truth. Wish there was a transcript. Has Stiglitz made these same points in print somewhere?

[bakho]

Shorter Stiglitz
Volcker and high interest rates were wrong.
Monetarism is a discredited philosophy and a religion.
Greenspan was wrong.
Bernanke learned the wrong lessons from the Great Depression.
We are using the wrong models.
A single agent models says nothing about borrowing and lending.
The models we are using are wrong.
CEO have not delivered and are overpaid.
Shareholders are stupid.

Did I leave anything out?
He didn't say anything about stupid fiscal policy and dumb and dumber politicians. That must have been the previous speech.

[doh]

Let's burn down the observatory so this never happens again!

[ideogenetic]

bakho, Stiglitz mentioned the failing of the politicians in not recognizing early on that Wall Street's financial motives were paradoxical and harmful to the macroeconomy? Regulation was called for. Stiglitz pointed out that Wall Street was claiming to lower transaction costs with their new and improved financial engineering but their fees were in fact increasing transaction costs! Stiglitz asked the question, why did the markets not recognize the paradox? It was completely irrational of the finance wizards on Wall Street to hold these mutually exclusive beliefs.

The politicians' greatest failure, as Stiglitz noted, was allowing private rewards and to continue damaging social returns.

"As a regulator, as an investor, I see that's going on and I say, 'Something screwy's going on.' It's pretty clear what's going on- fraud." - Joseph Stiglitz, excerpt from question and answer section.

[Winslow R.]

Stiglitz talked about corporate avoidance of taxes.

Just triggered my thoughts on quasi-private interest farming which provides little flexibility when profits are falling.

Interest farming will drive corporations and individuals out of business with no social imposed limits as society has been fed this belief that banks (and the financial sector) are private entities and therefore deserve to retain all profits even during times of duress. We must recognize the government backstopped financial sector, that which is provided shelter by the government, has no right to be a profit making enterprise at anytime.

Investment banks, the ultimate interest farmers, ran for shelter as soon as government unfurled the umbrella against the approaching storm.

Public controlled tax policy has a much more holistic approach to extracting real wealth. It avoids killing the goose that lays the golden eggs. The banking sector has no such qualms.

[acerimusdux]

He called inflation targetting a religion as well, and pretty much blamed Bernanke for destroying the financial system.

Bernanke believed that, because the mistake during the great depression was contracting the money supply, what he had to do to avoid that was keep increasing liquidity. But what he did by this was keep encouraging more reckless lending. He says that he ignored the impact of increasing credit on financial fragility.

In addition to saying he used the wrong model, he says the right model for understanding the Great Depression was Irving Fisher's debt defaltion theory. He also mentions Minsky's work on financial fragility.

On monetarism, he talked about how when they tried it, it was a disaster, and interest rates immediately shot up, and says it caused the debt crisis in Latin America. Says Volker's attitude, told these policies would wreck several nations, was "it's not may mandate".

[a]

"Are Economists to Blame for the Crisis?"

Oh, so when another economist says "yes", economists listen. When non-economists say it, economists turn a deaf ear. Is there any better example that economists are indeed to blame (in part) for the crisis?

[Lafayette]

THE economic truth

Galbraith Pere: So, to quote Friedman’s great intellectual nemesis, John Kenneth Galbraith, “Milton Friedman’s misfortune is that his policies have been tried.”

Most economic policies have been "tried" -- from Ghengis Kahn to Friedman to Laffer. They all occupy their place withing our policy firmament.

There is not one that is all right or all wrong, all the time.

The truth, be there one economic truth, I submit, is somewhere in the middle and borrows from each. By iteration, America will find it ... somewhere. Probably where others have gone before but not succeeded entirely.

[Lafayette]

a: Oh, so when another economist says "yes", economists listen.

Yes, the one handed economists. Rare birds, though.

The others remain mutually skeptical.

[jonfernquest]

"Stiglitz pointed out that Wall Street was claiming to lower transaction costs with their new and improved financial engineering but their fees were in fact increasing transaction costs!"

He specifically cited the Modigliani-Miller theorem here. The details are important, that's why a transcript is important.

The point about real sector wage rigidities being emphasized and taught over financial sector deficiencies was important too (Hyman Minksy vs. Hicks).

There is an important syllabus and conceptual vocabulary here, not talking points but an analytical framework for thinking out problems without getting bogged down in math that too easily becomes self-referential and divorced from empirical roots.

The part about inflation targeting in monetary policy is very important for countries like Thailand (where I live and work) that are currently debating these very issues

Developing countries luckily seem to enjoy an advantage of technological backwardness as far as sophisticated financial engineering is concerned.

Technology getting ahead of human ability to control may be an essential theme of the crisis, a point he makes with the speeding analogy.

[hari]

May be economists would tell the truth more often, if the bloody statistics was also accurate and reflected the truth of the goings-on in the national economy.

I might add, I have still to come across a national statistics which is fool proof... in my more than thirty years of profesional life.

However this is not to excuse Mark and his collegues from trying to improve how we, for example, accurately define CPI and the rest of stuff that makes up the GDP annually.

[acerimusdux]

"There is an important syllabus and conceptual vocabulary here, not talking points but an analytical framework for thinking out problems without getting bogged down in math that too easily becomes self-referential and divorced from empirical roots."

Yes, but the math is useful as well.

One of the things he mentions, for example, about education, is how the two welfare theorems are routinely taught in a way that reinforces the idea that markets are efficient. But seldom mentioned alongside them are his proof, about 25 years old now, that in the presence of either imperfect information or incomplete markets, markets are not Pareto efficient [the Greewald-Stiglitz Theorem].

Which is to say, in the real world, where those conditions always hold, there always exists a potential government intervention that will improve welfare. So why are students not taught that optimal outcomes always require some form of government intervention? He hammers home that too many economists simply choose to ignore the science in this way when it contradicts their preferred myths.

He also talks about teaching Mogdigliani, and how he taught first the value of diversification, and then the next third of the lecture was about how it didn't work if risks are correlated, and then the last part was about the moral hazzard problem involved in securitization. He says the people on Wall Street must have only paid attention to the first part of the lecture. (Really meaning again, I think, that people are selectively believeing what they want to believe, ignoring what is inconvenient, and calling it economics).

[Lafayette]

hari: if the bloody statistics was also accurate and reflected the truth of the goings-on in the national economy.

They don't have to be "exact". Indicative is enough for policy decision making. Whether unemployment is rising 0.5% per month or 1% per month is not centrally relevant to the fact that something must be done. The policy tools at hand are not sufficiently precise to offer a differentiation in usage based upon the statistic's value.

It is political immobility that is the grit in the mechanism, not the statistics. Methinks.

There are lies, damn lies ... and statistics.

[wjd123]

backo,

Stigliz also asked how financial services in Europe could have been so stupid as to buy 50% of our subprime products that were on their face bogus. There was no talk of "no one could have known" but how could European financial marketers not have known. Ouch.

He didn't think much of the cost of buying votes in our our democracy--over a $100 billion to pass a $700 billion bailout.

[BJ Feng]

Stigliz own analysis is wrong because he falls into his own trap of using models that don't capture the entire set of variables. Specifically, he states that firms and shareholders are stupid for paying more taxes through a dividend policy rather than through buybacks. He obviously has no clue about the subject, and makes the mistake of assuming a perfectly functioning environment where the management always acts in the best interests of shareholders and are wise enough to execute buybacks at the right time. Funny that he criticizes others for assuming perfect conditions when he does the same.

Dividends, unlike buybacks, have to be paid out once declared. A firm can suspend its buyback program at anytime, and there is NO guarantee that ANY amount of stock will actually be bought back. A buyback program merely authorizes a firm to buyback a maximum of such and such shares. A shareholder has no idea when the buyback plan will be executed, and when it will stop until after the fact. So a shareholder who does not want to reinvest the money that is being "returned" to him, has to guess and sell his shares in order to get money from the company. A dividend automatically gives money to the shareholder, and the shareholder is free to use that money to reinvest by buying more shares, or keep it.

Furthermore, a buyback almost guarantees that the firm will be buying shares when the price is "high", instead of low. The firm is most able to execute a buyback when profits are high and they have a substantial cash cushion for the buyback itself. The health of the firm will be reflected in the stock price. Why aren't financial firms buying back shares now? Why doesn't Citigroup start buying back shares now that they've dropped off of a cliff? Why doesn't Goldman do the same? Oh, because they have NO MONEY right now! But Goldman did buy a whole bunch of shares when the price was at $220. Humm, now that they have no money, that factor is reflected in the stock price. So buybacks almost always will ensure shareholders buy at the worst times. With dividends, the money is separated from the company immediately and held by the shareholder, who CAN buy at these prices.

Buybacks are tied to the underlying firm, dividends, once issued, are not. Dividends are better for shareholders because they give shareholders more flexibility. Buybacks are better for management if they receive options since prices should move up at least temporarily through buybacks.

Stiglitz should give examples that avoid exposing his own ignorance and stupidity. The greatest fault is that Stiglitz doesn't give us the "right" model, or tell us the magic formula. How do we know we're wrong? With Stiglitz, I guess we know when the economy goes to hell. Then someone like Stiglitz can stand up and with the aid of perfect hindsight, point to every "obvious" mistake and flaw. So which model should we use to solve this financial crisis? Stiglitz would say, ask me after it's over.

[save_the_rustbelt]

My wife, who has never taken an accounting, finance or economics class, moved a large chunk of our money to cash about 10 months ago.

She saw the rampant real estate speculation plus the accelerating rustbelt deterioration as sure signs of impending doom.

Common sense trumps smart almost every time.

[BJ Feng]

Save the Rustbelt, we've had these conditions for years now, these exotic type loans have been widely used since at least 2003, and I'm being generous. There are always going to be "risks" involved and uncertainty. Remember all the talk about a recession in 2004, 2005, 2006, 2007, and now? Mixed in were growing trade deficits, the looming collapse of the dollar, then the rise in commodity prices, then hedge fund dominance, and let's not forget the rise of London and the obsolescence of New York and America as a financial center. There always are hints and clues and doubts, finally one of them turned out to be real and also severe.

I would say that your wife was lucky to make the right move, of course you probably should tell her she's a genius, but I wouldn't automatically assume whatever she wants to do in the future will turn out as well.

[ScentOfViolets]

I think this is a little harsh. I don't think events would have played out much differently if more prominent economists had been more public and forceful with their objections to policy.

It's just that economics was used as a 'scientific' reason to do what certain parties wanted to do and were going to do anyway. Absent the 'science' behind the actions, other pretexts would have been found to justify what were and are quite obviously self-serving maneuvers.

[Voltaire]

Keynesians...of course. Austrians...of course not!

[paine]

the hicks vs minsky bit
was very toonish

spooning with fisher ?????
a private joke ???

however
i liked the sharp elbow into woodford's gut

its too bad
joe has the charisma of a cow flap

speaking from a seated position
with head swivelling side to side
maybe made him feel fdr ish
but he ain't no fdr

ps

fengula

gibbers on
buy back your comments

[paine]

laff

"There is not one (economic policy )
that is all right or all wrong, all the time"

u give banality a second best award

[paine]

what we are seeing ....obviously
is the utter failure
of one eyed macro
ie
the collapse of the near consensus
among main stream economists
these last 30 years or so
that well anchored wage growth
enforced by shrewd monetary policy
nearly alone
could
get the stabilization/growth
job done

[hari]

Intuitively I think you can negate some of the stupidity in macropolicy making if the political hacks are not the key elements in the policy process - as in current White House staff.

Alternatively with a permanent professional staff or a civil service establishment in WH dealing with policy process across the board, I suspect a lot of the pitfalls in decision-making can be avoided. Simply because amongst professional without political ladder or commitment to worry, the process of selecting what's relevant and whatnot becomes a lot more objective, in the final analysis.

Stiglitz is, for sure, condeming the dismal science for its lack of backbone - ie. political neutrality.

[Patricia Shannon]

ScentOfViolets
said true.

[Lafayette]

wjd : Stigliz also asked how financial services in Europe could have been so stupid as to buy 50% of our subprime products that were on their face bogus. There was no talk of "no one could have known" but how could European financial marketers not have known.

If this is true, it shows that he knows little about how the investment vehicles were structured/sold.

The Europeans were duped just like everybody in the US. Does anyone really have the time to look behind a triple-AAA (high return, backed by real estate) mention from a rating agency?

Not really, they believed the agencies’ fraudulent ratings. Either the agencies did it in connivance with those who packaged the SIVs or they did not do their “due diligence” and investigate them with any great precision.

Whichever, they should be all good for perp-walks.

[jonfernquest]

BJ Feng: "With Stiglitz, I guess we know when the economy goes to hell. Then someone like Stiglitz can stand up and with the aid of perfect hindsight, point to every "obvious" mistake and flaw."

There were prophets yelling in the wilderness before it happened that no one listened to.

Taleb's fooled by randomness is echoed in the NY Times Fannie Mae story where the **quants are in the background giving some negative risk assessments were routinely ignored** (warnings with foresight not hindsight) because it conflicted with other immediate profit maximizing objectives, since in the long-run when regulations really matter, we are all either dead, hunkered away with our winnings from gaming the system, or broke.

acerimusdux says.."the people on Wall Street must have only paid attention to the first part of the lecture. (Really meaning again, I think, that people are selectively believeing what they want to believe, ignoring what is inconvenient, and calling it economics)."

When things get supermathematical generalists are replaced by hyper-specialists. Compare Bagehot or Keynes with some computational finance star.

[save_the_rustbelt]

BJ:

"I would say that your wife was lucky to make the right move"

Do you think she was merely lucky because
a) she's a woman, or
b) she has no financial training

Anyway, I praise her constantly, as she is quite praiseworthy, and is able to cut through immense amounts of bull because she has common sense and intuition. And when she is not saving lives or making shrewd judgments, she makes a great apple pie.

[BJ Feng]

save_the_rustbelt, I believe very few people have the ability to profitably time the market. Doing so is incredibly difficult, I've followed the market for 13 years and I have the majority of my holdings in index funds because I'm not gifted enough. I remember plenty of false signals, from the Asian Debt crisis of 1998 that sent the markets tanking, to the meltdown after 9-11. We tend to forget the times when bad prophecies don't come true, but check the financial pages and we're always worried about something. The saying is that stocks climb a wall of worry, it's rare that we have unfettered optimism like in 1999, and they are even more dangerous.

I said she was lucky because had she picked one of the other times, she would have been wrong. I could also be wrong about her too, but her job is only half done. Market timing requires two moves, one to get you out, and another to get you in. Maybe you will inform us when your wife decides to re-enter the market. The second part is often as difficult as the first. I remember back in 2002, stocks hit their lowest point just as the Worldcom and Tyco accounting scandals were brought out in full light. I remember thinking how many of the other S&P500 companies had faked their earnings, what if they were all fake? The market was also very worried, Jim Cramer predicted the DOW would go to 6500, it never did, that was the low. When no more large scandals were revealed, the markets started moving higher. We hit bottom when things look the worst, but we can only know what "the worst" looks like AFTER the fact, in hindsight. Back in 2002, I didn't know how bad things could get, only in 2008 can I say what the worst was.

[Sam Z.]

Great talk. But Stiglitz spends a lot of time asking why people were "stupid" in using the wrong model. This is similar in spirit to Nassim Taleb's critique of excessive reliance on certain convenient density functions in risk analysis. However, like Nassim Taleb, I think Stiglitz underplays just how effective these bad models have been in providing an pseudo-intellectual framework for what can only be called looting. The core of the Taleb-Stiglitz critique is that the models were wrong. But when a lack of understanding just so happens to greatly increase the wealth of one small group at everyone's expense, you have to
wonder if these are "stupid" errors, or semi-deliberate ones. To paraphrase Galbraith: it's hard to get a man to use the right model if his own income depends on him using the wrong one. (To be fair Stiglitz responds to this point in Q&A at the end, but I think it needs to be emphasized more: this wasn't just random dumb mistakes, but a very successful policy of wealth capture, with the models playing the role of an intellectual fig leaf.)

Sam.

[acerimusdux]

I though his comments about the dividend paradox were meant to demonstrate that firms and shareholders aren't always rationally and efficienctly maximizing shareholder value.

He used the example of the inefficiency of dividend policies in that context. And talked about how it was a case of both management and shareholder stupidity; that management even when shown the high costs, tended to be resistent to any change in publicly held firms, and only in closely held firms were they likely to take advice that minimized tax payments and increased shareholder profits.

And, I think BJ himself shows ignorance of the models when he uses a bankrupt firm to demonstrate his point; when having no risk of bankruptcy is the most critical limitation to the theory of irrelavence of financial policy.

It may be helpful to point out here, as regards to wrong models, that most often it is not really the models themselves that are "wrong"; it is how they are applied. All models contain simplifications which won't be directly relevant to the real world. What is critical for understanding the relavence of a model is often not the result, but the limitations.

The other benefit of dividends which BJ cites, shareholder flexibility, really depends on another more minor limitation, which is that individual borrowing costs may not be the same as firm borrowing costs. In theory, if the shareholder wants a payment, he could always sell shares, or borrow money. He is thus in the same real position as if the firm had dilluted shares, or borrowed money, in order to finance a dividend. In the real world, where Individual shareholders won't have borrowing costs that are equal, but will have substantial flexibility to rely on other financing, the costs that do exist here are obviously quite small compared to the large tax penalty of dividends.

As for the point that firms may end up buying shares at the wrong time, again that merely reinforces Stiglitz's main point; that firms are not very rational or efficient in these decisions with regard to maximizing shareholder value. If firms had a meaningful understanding of their own real operational fundamentals, they would be able to recognize when their shares were over or undervalued, and time purchases wisely. Thus, I would say that BJ does not make a very reassuring argument in favor of firms understanding the profitability of their financial allocations, if it depends on their ignorance of the profitability of their capital allocations.

Far from having "no clue about the subject", Stiglitz laid all this out pretty clearly over 35 years ago in his academic work. He cites it here as an example of how there are gross failures in microeconomics as well as macroeconomics.

[acerimusdux]

A quick follow up to the above, here is a paper form Stiglitz from 1972:

On The Irrelevance Of Corporate Financial Policy

I think part of the lesson of the model in which bankrupcy does not exist, is that if corporate finance is irrelevant under these conditions, then in the real world, where bankruptcy does exist, this should be a primary concern of finance decisions.

In other word, he actually used this theoretical work to emphasize the importance of financial structure. Just as Minsky essentially emphasized financial structure on the macro level.

The point is that, academically, in finance classrooms, far too much time is spent on far less signifcant aspects of corporate finance, and not enough emphasis on financial structure and stability. Just as in macro classes, we have neglected Minsky, Fisher, et. al.

[BJ Feng]

Acerimusdux, actually the key assumption is that management always acts in the best interests of shareholders, but beside that, there are several other very important negatives to share buybacks. Share buybacks reinvest earnings back into the firm, however the company might not be the optimal investment for a shareholder. If other companies in its peer group are trading at lower P/E ratios, then there should be a compelling reason for management to make the decision for the shareholder to reinvest earnings back into the company. Yes the shareholder can sell, but he faces a host of challenges due to imperfect information. As I stated, the shareholder doesn't know when the share buyback will be executed or how much of it. Without that information, he will have to wait for the announcement that the buyback plan has been completed, otherwise he could sell before the company starts to buyback. Secondly, he is exposed to market variance, stock prices fluctuate and he might well sell at a low point in those fluctuations, even if we say that on average he sells at the "fundamental" value, still the variance is negative and imposes a "cost". There also is the real cost of the transaction, not only dealer commission, but bid/ask spreads. With a dividend, the shareholder gets his money without any more hassle and any more fees, that is a real benefit and is worth something.

Furthermore, the buybacks are a form of retained earnings, the shares are stored in the company's treasury and can be used to purchase another company. So as the company becomes more valuable, the shareholder is exposed to more and more manager risk. Even if the manager is 100% loyal to the shareholder, he still is human and might make a foolish acquisition using the stock of the company. And acquisitions almost always have to be made with a premium to market prices! A shareholder can buy Yahoo stock on the market, but if Microsoft wants to purchase Yahoo at all, they probably have to take a substantial stake with the permission of that company or else make a full offer to takeover the company. Companies outside the financial sector do not make passive investments in other companies as they have no expertise in asset management, there is no reason for Microsoft to buy Coke shares or BOA stock. So if a Microsoft wants to purchase Yahoo, it has to pay a premium above market in order to gain control. That makes it very difficult to get a good bargain, though synergy gains could be larger than the premium. Regardless, if a corporation pays out a dividend, that money is gone from the company forever, it cannot be used to fund a takeover attempt later. And takeovers are limited by the size of the target and the acquirer. An AMD simply cannot afford to takeover an Intel, but Intel can afford to takeover AMD. Dividends limit the "harm" that a dumb takeover, like Wachovia's takeover of Golden West which destroyed Wachovia, can impose. Dividends cannot be "lost" once issued, the buybacks are retained by the company which puts them at risk, all it takes is one mistake by management and the company is destroyed along with all the buybacks ever executed by that company.

The main point is that dividends give shareholders more flexibility and offer benefits that may be worth more than the additional tax cost. Shareholders face transaction costs if they sell shares. And if we venture more into reality, the benefits of share buybacks are indeed questionable, while dividends can be easily measured.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=647843

"Abstract:
The positive stock price reaction to stock buyback announcements reported in many previous studies is commonly interpreted as a signal that the firm's future profitability will rise, or that the firm is decreasing its agency costs by dispersing free cash flow, or that the firm is increasing its leverage toward a more optimal capital structure. We examine a sample of 7,079 buybacks (open market and tender offers) announced between 1981 and 1995, and follow each firm for five years after their buyback announcement. Consistent with prior work, we find that our sample firms repurchase most (and more in many cases) of the shares that they target in their announcements. We also find, however, that our sample firms issue shares following buyback announcements. In fact, our average sample firm increases its shares outstanding 23.73 percent following its buyback announcement, and our typical sample firm has an insignificant change of -0.88 percent. With no change in shares outstanding, our results are generally not supportive of commonly accepted buyback theories. For example, we find no consistent evidence of positive long-term abnormal operating performance or stock returns following buybacks; we also find no consistent evidence of a decrease in cash flow from financing, or an increase in the firm's debt ratio or default risk. Instead, we find that the buying and selling of their own shares that firms do following buyback announcements increases their stock's liquidity and this explains the positive stock price reaction to these announcements."

[BJ Feng]

Stiglitz was foolish and used a wrong theory himself to supposedly point out the "wrong" and "irrational" behavior of issuing dividends. Stiglitz would be better served TO USE HIMSELF as the dumbass who goes and puts faith in models that don't work in reality and are contradicted by observations. In the end, models are imperfect because there are so many variables in reality. I've only mentioned a few that make dividends more attractive than stock buybacks, there are many more, but models are useful because they are more "simplistic" than reality. We want something that approximates reality, without having to calculate every single variable. The result is that accuracy suffers, we must exclude some factors. What makes a model good is that what it excludes is "unimportant" enough that the results approximate reality to a good degree. Again, that makes models vulnerable to extreme or unusual situations because those variables don't pop up often and so are excluded from the model. That's part of the reason for the breakdown of standard economic models in times like the Depression.

[jonfernquest]

excessive liquidity in the economy + housing bubble + moral hazard of securitization + mathematically complex untransparent derivatives on top of that (e.g. insurance without actuaries, regulation, or reserves) + leverage to the gills = TIME BOMB

[Ronald Rutherford]

Stiglitz like usual shows his partisan like any other so called economist...
Now did I hear for some more deregulations on about minute 29???
I have to wonder if what little information is dangerous for him to know also. Along those lines, I am always suspicious of people from one profession to tell other professions that they are morons {stupid} like in his supposed perfect knowledge about the tax structures in the USA. He never did explain how to lower the tax burdens for distributing firms retained earnings to shareholders.

Of course no Democrats promoted perverse incentives...

[wjd123]

Lafayette,

Stiglitz said it amounted to believing in alchemy to think someone could take a bunch of junk products, lead, and get from them triple A rated products, gold. .

Add to this the fact that the companies rating these products were being payed by the very people who had a vested interest in the outcome. It's too kind to say that the European institutions buying these products didn't practice due diligence. They were stupid.

Stiglitz apologizes for such a harsh pronouncement, but he doesn't back away from it. Believing in the ability of financial wizards to turn lead into gold is stupid. The rating agencies duplicity is no excuse for the buyer's stupidity.

I think the sellers, the modern day alchemist, who were producing these products should be labeled criminals. These financial wizards were the end product of the best our educational system had to offer. When their time came to repay society for all the advantages lavished upon them they decided to rip it off instead. They sold us debased metal as gold, and they left not only America but the world littered with dysfunctional financial institutions.

Their attempt at modern day alchemy shouldn't be excused as human folly. What they did was morally reprehensible, and they should be treated as criminals.

I've been listening to CNN financial news. If I here one more time how Wall Street was hoodwinked by the poor or forced to do what it did by the government, I'll throw up. Wall Street was playing fast and lose with a financial system it had an obligation to respect. Instead, it abused it in order to line its pockets.

[Lafayette]

wjd: The rating agencies duplicity is no excuse for the buyer's stupidity.

Legally, you have got this notion dead wrong.

When you are recognized as a professional crediting agency, it is gross neglect to not investigate the underlying foundations of the SIV. And, if you do and still rate it as triple-A, then the agency is guilty of fraud. (I’ll bet the FBI is looking precisely for any documentation that demonstrates that such was done.)

In either case, it is NOT the buyer's duty to undertake the credit agency's responsibilities. Any notion in this sense is assbackwards. Ask a good lawyer.

You buy a new Chevy and the brakes don't work and you have a serious accident, with loss of life or limb. GM is going to argue before a court of law that is was YOUR responsibility to test the brakes?

No way, José.

[Lafayette]

Not equally, but equitably

acer: that firms are not very rational or efficient in these decisions with regard to maximizing shareholder value

The above notion shows a lack of comprehension of how corporations run.

Companies do not Maximize Shareholder Value as a direct objective. Companies first maximize customer satisfaction in as many ways as possible, the consequence of which is profits ... and thereby shareholder value.

Those who think CEOs run home every night to look at their stock's closing price are quite wrong. Any CEO will tell them that the idea is laughable.

More so, the CEO intends to run a tight ship that is doing everything possible to satisfy customers such that HIS/HER shareholder value is maximized. They could not give a damn about anyone else. Business is not a matter of community welfare, but individual motivation. Which is part of the problem.

A company that succeeds in maximizing customer satisfaction is one that is running like a well-oiled engine -- with all its parts moving harmoniously. If a CEO can get the organization to work like that, then they deserve their stock options. As do the well oiled parts. After all, isn't good Execution as important as Leadership?

And, if it is, then why not share the stock-option pool with other colleagues in the company who contribute just as vigorously to its success?

Not equally, perhaps, but equitably.

[wjd123]

Lafayette,

Stiglitz' complaint is about the suspension of common sense. You can't change lead into gold. The European institutions that were buying our subprime paper should have known better. It was obvious that our credit rating agencies were compromised. They were being paid by the same people issuing the paper.

I've been watching CNBC financial news [not CNN] and I'm getting tired of Wall Street's excuses for it part in this mess. It, and it alone, came up with the products based on subprime loans, not the poor or the government. If Europe is going to start blaming its institutions credulity on our rating agencies, that too is going to get old in a hurry.

Europeans have their own stupidity to blame for the situation they are in. Are you familiar with the saying "Who are you going to believe me or your lying eyes"? Despite all the evidence to the contrary Europe's financial leaders decided to believe Wall Street.

Evidently the building in which Stiglitz made his remarks had a religious motif. He made the comment that the Catholic Church has been more constant in its beliefs about economics than modern day economist. Here is what one of its earliest writers, St. Luke, had to say about a city headed in the wrong direction, leaders relying too much on the letter of the law and not enough on its its spirit, and financial services at the time of Jesus Christ:

When he came in sight of the city, he wept over it and said, "If only you had known, on this great day, the way that leads to peace? But no' it is hidden from your sight. For a time will come upon you, when your enemies will set up siege-works against you; they will encircle you and hem you in at every point; they will bring you to the ground, you and your children within your walls, and not leave you one stone standing on another, because you did not recognize God's moment when it came."

Then he went into the temple and began driving out the traders, with these words: "Scripture says, 'My house shall be a house of prayer'; but you have made it a robber's cave."

Day by day he taught in the temple. And the chief priests and lawyers were bent on making an end to him, with the support of the leading citizens, but found they were helpless, because the people all hung upon his words.--Luke 19:41-48, The New English Bible

Yikes! And Stiglitz thought he was harsh calling the European leaders stupid. I thought his views were a little on the prophetic side in tone, but they were nothing like that.

[BJ Feng]

No, securitization is a sound method. We can make AAA securities from subprime mortgages, just like we can filter clean water from a cesspool. The question is how much "clean" water we can get. Clearly not as much as the rating agencies thought.

Yes there is a problem with the agencies and how they operate. Government regulations give the agencies a huge amount of power. They can force a company into bankruptcy like what they did with Lehman by downgrading the bonds that they had initially graded AAA to junk. That forces Lehman to put up more capital in a vicious cycle of destruction. Yet the ratings agencies aren't punished for making huge and substantial mistakes. It doesn't matter how wrong they are or were, they get to continue on. Where is the incentive to be right? Where is the incentive to do their job?

[wjd123]

No, securitization is a sound method. We can make AAA securities from subprime mortgages, just like we can filter clean water from a cesspool. The question is how much "clean" water we can get. Clearly not as much as the rating agencies thought. --BJ Feng

BJ Feng,

That's a good argument and a good analogy. Yet, I prefer Stiglitz' alchemy analogy better. Not only do I think it's closer to the truth, but it leaves less room for Wall Street to make excuses and Europe to start pointing fingers.

[Lafayette]

Utterly Unbelievable

wjd: The European institutions that were buying our subprime paper should have known better. It was obvious that our credit rating agencies were compromised.

Obvious to who? You? Why didn't you tell the world? Or, do you work for a credit rating agency, perhaps?

Look, I've talked to guys in investment banking in Paris. They did NOT know the SIVs were toxic waste or they would not have resold it.

They assumed the rating agencies triple-A qualifications were bona fide. After all, these rating companies had been in the business since the 19th century.

How is it that you can assume that such a humongous fraud could be perpetrated on so many people around the globe, and nobody snitched publicly before 2007? That the WHOLE INVESTMENT BANKING WORLD knew that the SIVs were toxic waste and resold them anyway -- keeping it on the QT until the bubble burst. All of which makes for yet another Utterly Unbelievable Conspiracy Theory.

This crime makes the Mafia seem like little boys playing in a sandbox. And a crime it is ....

[wjd123]

Lafayette,

Stiglitz knew it, and most people who call themselves economist should have known it if they were relying on empiricism instead of idiological doctrine--economics as religion. Even though beliefs based on rite and doctrine go against the modern spirit of secularism, Why do economic schools sound like waring religious factions? Because for the purpose of motivating changes to our political economy or keeping changes from happening, religion trumps secularism.

[wjd123]

Lafayette,

On a more parochial level, nothing concentrates the mind to believe something as the prospect of making a living from it. In the movie "Ghostbusters" they were interviewing for hired help. One of the questions was "Do you believe in the paranormal?" The answer given by the guy being interviewed was that he would believe in anything if there was a job in it for him. Most people aren't that cynical; however, ascribing to the same beliefs, for many in different professions, is a matter of peer pressure and the fact that believing helps keep food on the table.

[hari]

WJD - You're scapegoating the real fraud with SIVs. Stiglitz may sound to you, now, as a God! He ain't! He was dismissed by Clinton as Chairman of Council of Economic Advisors - for a good professional reason. Tyson replaced him, and he's never forgiven the establishment for it.

You get carried away with your apparent lack of intellectual accumen as to why it's so convenient for someone like Stiglitz to fill in the ccurrent vaccum and decry the ills of official policy making.

However he has been more righteous on Iraq and the cost of war, which I agree.

EU was unable to challenge the (US) ratings agencies principally because they'd a (S$P) track record and backing of US financial institutions including Fed/Treasury.

I've pointed out it's time to discard institutions like Investment Banks and Hedge Funds - perpetrators of the cabal which disseminated SIVs thru their collective marketing assault on global finance. In turn, they paid for the rating agencies to issue AAA ratings for the mortgage derivatives diced/sliced/dipped in CDS.

If that does not qualify for definition of a sacreligious Cabal, what does or will? You haven't gotten your nose into the fraudulent swamps of the swaps or have you?

[hari]

I don't think you can blame the economists for the current crisis, and say nasty things about our host. As a profession, they have a difficult job to do principally because they depend to a great extent on official policy and published statistical evidence which forms their framework of policy. It's disengenous therefore to expect them to reinvent the wheel specially in a crisis.

Watch the way Paul is scrambling to identify relative truth -from what's really not true - as seen from his professional background and analysis. You simply can't expect or ask more than that from a conscientious pundit dealing with economic malaise we're going thru now.

Stiglitz is saying, more or less, I told you so! Now it's coming all true - something like that - you and I know for a fact the economic profession didn't anticipate as late as last Aug 2009 - when Bernake signalled Fed action.

That's why I plead for more of political economic thinking when dealing with policy making....not just theoretical economics.

[Lafayette]

An ounce of precaution

wjd: Why do economic schools sound like waring religious factions?

Because they are the battleground of ideas, they should be full of intellectual conflict. Otherwise they stagnate.

And yet, we see damn few academics coming onto this forum to defend their ideas. Either they could care less about public forums or they are intellectually cowards. I prefer to think the former ... but am not at all sure. Let's give them nonetheless the benefit of the doubt.

Because for the purpose of motivating changes to our political economy or keeping changes from happening, religion trumps secularism.

I suspect that the religion bit is given more weight in the political equation than it deserves. The troglodytic Right festers and fumes in righteousness, but hasn't a cogent thought to its credit. I prefer to believe that only a hardcore of the Religious Nutters actually takes the pain to vote.

Politics is the art of the possible amongst conflicting forces. It has little to do with fundamental issues of being right or proper. (Remember Kissinger's criteria of "plausible denial", meaning it is quite alright to lie as long as you can deny you said it?) Being right is an academic pursuit, not political. Being wrong academically has not the same punishment as politically.

Politics is tempered by public opinion. For a nation that is pretty well educated (supposedly one-third of all Americans hold a university degree), it is nonetheless amazing how it can get up to some of the most idiotic shenanigans ever invented on this planet.

One has a right to ask why, given the dimension of the resulting mischief. Perhaps it is due to the overwhelming belief that, with enough effort, anything is possible. This is an admirable quality in a person, often in short supply.

It would be far, far better if that person would think, first and with depth, whether that anything were the right anything. Apparently, that is not a necessary forethought. Or, are we afraid of "wasting time"?

The attribute of a action being possible does not make it, necessarily, correct. And an ounce of precaution is worth a ton of remedy.

[wjd123]

I don't think you can blame the economists for the current crisis, and say nasty things about our host.--Hari

Hari my friend,

What nasty things did I say about Mark Thoma? Stiglitz made a complaint about the economic profession in general, to often they treat their presuppositions as articles of faith. That faith gets in the way of empirical evidence that should test their faith. That certainly isn't the case with all economists. Mark Thoma I find is very empirical. Or should I say not resistant to empirical evidence.

I'm going to preface all my comments about Stiglitz' speech with the qualifier, as I understood him. What I understood him to say about the securitization of subprime loans was that it should have been obvious to those not blinded by faith that financial institutions were practicing modern day alchemy.

You're scapegoating the real fraud with SIVs. Stiglitz may sound to you, now, as a God! He ain't!

I have no gods in the economic profession, especially those who supported free trade as we know it today. I think of those--and Stiglitz was one of them--at best mistaken, at worst devils.

As you may know my New Year's resolution for the last few years is to do evil to corporations. If any group has attracted my wrath it's the financial institutions. My complaint has been that if your going to have internationalism you need international controls. I've been preaching that international finance should be regulated, adnauseam.

Let me sing my own praises, I've come out smelling like a rose.

[Lafayette]

Failure is an orphan

wjd: My complaint has been that if your going to have internationalism you need international controls. I've been preaching that international finance should be regulated, adnauseam. Let me sing my own praises, I've come out smelling like a rose.

Before prancing off into the sunset with pompous self-praise, know that regulatory controls on an international level have been proposed and discussed here in Europe longgggggg before ever arriving on American shores.

The head of the IMF is a Frenchman, amongst the foremost to believe in such controls. In fact, they are control freaks. But, at the same time, their banking system is coming out of this mess with one of the best capitalizations on this planet.

Furthermore, the most advanced work on such regulations has been made with the Basel 2 proposition. It probably does not go far enough given the present mess, but American opposition to further tightening is henceforth useless.

Frankly, we find ourselves in a pissing contest, which is not the purpose of real debate. Can we agree to disagree?

That would be a good start. And, maybe, we can get back to the center of the debate? Are economists the "agent provocateurs" or the victims of this crisis?

I say neither. I did not read all that much in the way of opinion against the wanton and fraudulent selling of toxic waste upon world investors whilst it was going on. There was a good amount of talk regarding the "real estate bubble", but that was not surprising. After all, Japan and Sweden were not far off in history as examples of such excesses.

What was lacking is the will to do something about it. And, that was a political problem. American politics works largely on an old Yankee dictum, "If it ain't broke, don't fix it". No one saw the awesome depth of this crisis. Certainly no economist did, because it was beyond macroscopic functionality. This was just a (sort of) giant financial Ponzi Scheme.

Economist can blame Greenspan for his laxist "laissez-faire" attitude throughout this and the previous dot.com boom 'n bust. But, he had presidents of either party backing him all along the way. Because it worked, for a while.

Success has many fathers, but failure is an orphan. Greenspan must be feeling pretty much alone nowadays.

[hari]

Yes! You do but have some tolerance for human intellectual arrogance and not put it in overdrive pls! Lots of mistakes have been made by lots of greedy and not so greedy executives. The result is the failure of turbo capitalism a la America, as I reported yesterday. In retrospect, the acdemic profession must be a bit more humble and eat their own pie!

[BJ Feng]

Hari, it's the ultimate hubris to think regulators can foresee and solve every problem before they become problems. Regulators are not omniscient, most of them are quite human, and like the rest of us, see things clearly only after they occur. No amount of regulatory control or law has been able to prevent financial crises from occurring every so often. Emperors, both Roman and Chinese could put to death thousands of men with a single word, yet they were powerless to stop financial panics. Newton invented calculus, but could not figure out the South Sea bubble until too late. FDR seized private gold with a single decree, but his decrees couldn't reverse the Great Depression. We will have another financial crisis sometime in the future, it's the ultimate act of delusion to believe that regulators, and regulations can stop what has been a natural process.

[hari]

The name of the game - going forward - get in the slow lane.
Hopefully there is some safety in that lane. Emerging Asian markets are also part of the *gambling casino* under turbo capitalism - need now to slow down and control the tillers!

With money there is no fool proof system to avoid mistakes, me thinks.

[Lafayette]

Greed displaced good sense

BJF: Regulators are not omniscient, most of them are quite human, and like the rest of us, see things clearly only after they occur.

C'mon, if the Fed had audited selectively the toxic waste it would have seen that the SIVs were not underwritten by credit-worthy mortgages. The Fed was asleep at the wheel.

Enough of this, "we're only human" nonsense. And let's put an end to the idiotic notion that the sky's the limit or that Free Market Principles are best for the nation. The sky has just come falling down about our ears.

The overarching lesson from this mess is that we trusted self-regulatory market mechanisms that failed us. Greed displaced good, common sense.

America is not the land of infinite freedoms for a small percentage of the population with which to screw mightily all the rest. It is, fundamentally, a land of equity and social fairness. Or, at least, it should be.

The subprime mess, let's admit it, is a linear extrapolation from the Reagan axe-murder of marginal taxation rates, which let loose the penchant for greed on Wall St.

We are paying the price of that greed ... and it ain't cheap.

[wjd123]

Hurrah for Lafayette! Except for the second to last paragraph because I don't know what it means.

[Lafayette]

Greed happens

wjd: Except for the second to last paragraph because I don't know what it means.

The last paragraph in question (from Lafayette): The subprime mess, let's admit it, is a linear extrapolation from the Reagan axe-murder of marginal taxation rates, which let loose the penchant for greed on Wall St.

In 1981 and again in 1983, during his first term, Reagan took an axe to marginal taxation of high incomes (read here). Over those years, they have dropped from 70/80% to 50% and then again down to the present 28%.

What does one think that a marginal rate of 28% on top income can does to nerdish Wall Street minds? Yep, it started a feeding frenzy at the heart of which was "innovative financial engineering".

Particularly innovative was taking all sorts of debt, packaging it, then reselling it onward -- and using it as a basis for derivatives (which were simply sophisticated futures contracts on debt) and is a market of its own.

This produced a speculative house of cards based purely upon debt - not commodities like corn (for which derivatives were invented in the 19th century) or pigskins, or chickens, but debt. The market value, unlike commodities, was colossal.

The balloon popped last year, but not after our Golden Boys had all caught the Golden Ring on this financial circus merry-go-round. Paulson escaped from Goldman Sachs with 250 megabucks, whilst various Top Management fat cats at Fannie and Freddie shared bonuses totaling more than 100 megabucks -- and these are just two examples.

Why did this happen? At a marginal tax rate of 28%, greed happens. It becomes pervasive and pernicious. Which happened throughout corporate America as boards voted hallucinatory compensation packages.

And if we do not pull up marginal tax rates, creative but greedy minds will attempt to do their money-magic (read “financial engineering”) again in the future. That is, if those rates do not go back up to stratospheric levels to prevent the greed from fomenting, then indeed we shall have another Great Financial Mess to add to the string of them that began in the 1980s.

Quite personally, above a certain amount annually (say $10M?), the tax should be confiscatory. Uh ... that means, for all practical purposes, 95%.

But, I guess, that would irk the wrath of God. Or, some such other Eternal Nonsense fixed in American mentality.